What Is a Zombie Firm?
A zombie firm is a company that generates just enough revenue to cover its ongoing operating costs and interest payments on its debt, but not enough to significantly pay down its principal debt, invest in growth, or innovate. These companies often exist in a state of suspended animation within the broader landscape of corporate finance, neither thriving nor failing, sustained by continuous refinancing or unusually low interest rates. Zombie firms are characterized by persistent low profitability and high levels of debt, hindering their ability to contribute meaningfully to economic growth and productivity.
History and Origin
The concept of "zombie firms" gained prominence following Japan's "Lost Decade" in the 1990s, where many companies, despite being technically insolvent, were kept afloat by banks reluctant to recognize bad loans. This phenomenon was linked to a weak banking system and prolonged periods of ultra-low interest rates. Research by the Bank for International Settlements (BIS) indicates that the prevalence of zombie firms has increased significantly across advanced economies since the late 1980s. This rise is partly attributed to reduced financial pressure stemming from lower interest rates, which eases the burden on firms and their creditors to address balance sheet issues.20, 21 Policymakers' actions to prevent widespread bankruptcy during economic downturns, such as the 2008 financial crisis and the COVID-19 pandemic, have also contributed to the persistence of these firms by providing various forms of financial support.18, 19
Key Takeaways
- A zombie firm is a company that can cover operating expenses and debt interest but struggles to invest or grow, existing in a perpetual state of minimal viability.
- Their proliferation is often linked to periods of low interest rates and bank forbearance, as lenders avoid writing off non-performing loans.
- Zombie firms can stifle overall economic productivity by tying up capital, labor, and other resources that could otherwise be allocated to more dynamic and productive businesses.
- Identifying zombie firms is complex, typically involving criteria such as a persistently low interest coverage ratio and/or low stock market valuation.
- The continued existence of zombie firms can pose a "difficult trade-off" for central bank monetary policy, as attempts to stimulate the economy with low rates can inadvertently perpetuate their survival.17
Interpreting the Zombie Firm
Identifying a zombie firm primarily involves analyzing a company's financial health, particularly its ability to service its debt. A key indicator is a persistently low interest coverage ratio (ICR), which measures a company's ability to pay interest expenses from its earnings before interest and taxes (EBIT). If a firm's EBIT is consistently below its interest payments, it may be considered a zombie. However, a strict ICR definition alone can be misleading, as some firms might temporarily have a low ratio due to one-off factors or high growth investments. More comprehensive definitions often include additional criteria, such as the firm's age, its balance sheet leverage, and whether it receives subsidized credit or benefits from low interest rates that might not otherwise be available to a firm of its financial standing.15, 16 The continued survival of zombie firms suggests a misallocation of resources within the economy, impacting market efficiency and overall dynamism.
Hypothetical Example
Consider "Stagnant Corp.," a manufacturing company founded 15 years ago. For the past five years, Stagnant Corp. has reported minimal or negative net income. While its operating cash flow is just enough to cover its monthly utility bills, employee wages, and the interest on its substantial corporate bonds and bank loans, it has no surplus capital for reinvestment in new machinery, research and development, or expanding its market reach. The company's liquidity is perpetually tight. Its lenders, fearing that forcing insolvency would lead to large loan write-offs, continue to "evergreen" its loans, extending maturities or offering forbearance on terms, especially during a period of sustained low market interest rates. Stagnant Corp. is a zombie firm because it is not actively growing or contributing to economic vitality, yet it persists by merely treading water, occupying market share and resources that could otherwise go to more innovative and profitable competitors.
Practical Applications
The existence of zombie firms has significant implications across various areas of finance and economics. For investors, identifying zombie firms is crucial for credit risk assessment, as these companies carry a higher risk of default or significant value erosion, despite their prolonged survival. They may also signal broader economic vulnerabilities.
From a macroeconomic perspective, zombie firms hinder productivity growth by tying up capital and labor that could be used more efficiently by healthy, growing businesses. This "resource misallocation" can slow overall economic growth and reduce market dynamism by creating "congestion effects" that limit investment and employment at more productive firms.13, 14 Policymakers, including central banks and governments, grapple with how to manage zombie firms. While supporting struggling businesses during crises can prevent immediate job losses, prolonged forbearance can impede economic recovery and structural adjustment. Reforms to insolvency regimes and addressing non-performing loans in the banking sector are often considered crucial to facilitate the exit or restructuring of these firms.12 A surge in corporate failures in some regions is anticipated, as higher interest rates increase the financial pressure on these debt-laden businesses.11
Limitations and Criticisms
Defining and precisely identifying zombie firms presents several limitations and criticisms. There is no universally agreed-upon formula or set of criteria, leading to variations in how they are measured across studies and institutions. Some definitions might be too broad, inadvertently including healthy but temporarily struggling startups or companies undergoing restructuring.10 Conversely, overly narrow definitions might miss many firms that are indeed zombies but disguise their true financial state.
A significant criticism is that policies aimed at preventing immediate bankruptcy or providing broad economic stimulus, such as periods of quantitative easing, can inadvertently enable the proliferation and persistence of zombie firms. While intended to stabilize the economy, these measures can delay necessary capital structure adjustments and creative destruction, where inefficient firms exit the market to make way for more productive ones.8, 9 The survival of zombie firms can distort competition, depress prices for healthy competitors, and raise their funding costs by competing for resources, thereby stifling overall innovation and investment in an economy.6, 7
Zombie Firm vs. Distressed Company
While often used interchangeably, a crucial distinction exists between a zombie firm and a distressed company. A distressed company is experiencing significant financial difficulty, often marked by declining revenues, negative cash flow, and potential default on its debt obligations. This distress can be temporary, caused by a downturn, a specific market event, or a business model in transition. A distressed company may have a clear path to recovery through restructuring, new financing, or operational improvements.
In contrast, a zombie firm represents a more chronic state of unprofitability and lack of growth, typically unable to cover its interest payments from operating profits over a sustained period. Its survival is often dependent on exceptionally low interest rates or the reluctance of creditors to enforce default, rather than its underlying business viability. While all zombie firms are distressed companies, not all distressed companies are zombies. A distressed company still has the potential for a meaningful turnaround and healthy profitability; a zombie firm, by definition, lacks this fundamental capacity for self-sustaining growth and positive equity generation.
FAQs
How do low interest rates contribute to the rise of zombie firms?
Low interest rates reduce the cost of borrowing, making it easier for financially weak companies to service their existing debt and obtain new financing, even if their underlying business is not profitable enough to grow or pay down principal. This reduced financial pressure allows them to avoid bankruptcy or restructuring, prolonging their existence.5
What are the economic consequences of having many zombie firms?
The presence of many zombie firms can lead to lower overall economic growth and productivity. They tie up capital, labor, and other resources that could otherwise be deployed by more efficient and innovative companies. This can reduce investment, hinder job creation in healthy sectors, and stifle market competition, ultimately slowing down the economy's dynamism.3, 4
How can a zombie firm exit zombie status?
A zombie firm can exit zombie status by undergoing significant restructuring, improving its profitability through operational changes or strategic shifts, or successfully deleveraging its balance sheet to the point where it can comfortably cover its debt obligations and invest in growth. In some cases, a change in market conditions, such as a strong economic upturn, can temporarily boost revenues and help a firm improve its financial standing. However, studies show that firms that recover from zombie status often underperform compared to companies that were never zombies.2
Do governments or central banks intentionally create zombie firms?
No, governments and central banks do not intentionally create zombie firms. Their policies, such as maintaining low interest rates to stimulate the economy or providing emergency support during crises, are aimed at broader economic stability and preventing widespread job losses. However, an unintended side effect of such interventions can be the extended survival of companies that would otherwise fail in a more competitive or less accommodative financial environment.1